Risk to Reward Ratio in Forex – It’s simple. You cannot make money in forex trading without managing your risk. The best metric to help you is the risk to reward ratio.
Unfortunately, many traders are not aware of the same. It is essential to know about the risk to reward ratio before executing any trade. We will go into the details now.
What is the risk to reward ratio in forex?
The risk to reward ratio in forex refers to the amount of money you are willing to lose if the stop-loss hits. It is for the money you stand to gain if you hit the target. It is a measure of the amount you can lose to the amount you can earn on the trade.
For example, if your target is 20 pips (A single pip is 0.01), and the stop-loss is five pips, the risk to reward ratio is 5:20. You can also simplify it to 1:4.
So, the risk to reward ratio is in favor of reward. When the potential reward is higher than the risk, a trade is worth going for.
The average trader would have the question, how to integrate it into your forex trading? We will answer that below.
How can you use risk to reward ratio in forex?
The basic premise of the risk to reward ratio in forex is to opt for trades having a higher reward as compared to the risk. Only then, in the longer term, a trader can make a profit.
Ideally, the reward needs to be as high as possible, and the risk as low as possible.
For example, if the risk to reward ratio is 1:4, even if you hit stop-loss on one of your trades, you will still be profitable on a net basis.
Incorporating this into your trading strategy will be dependent on the type of strategy you choose.
For example, if EUR/USD has just broken past a resistance level and the next resistance is 100 pips higher, and the stop loss is 15 pips lower, the risk to reward ratio is roughly 1:7. In that case, going long is a good idea.
What precautions should you undertake while using risk to reward ratio?
There are a few precautions to always keep in mind while using this ratio.
• When indulging in news-based trading, there might be wild swings in the prices. The risk-reward ratio can quickly turn against you. The risk-reward ratio is suitable only for technical trading. You have to remember this when using the same.
• On the day when there is high volatility in the market, the risk to reward ratio might not be usable.
• The risk to reward ratio forex is just an additional factor to bolster your strategy. It cannot be considered as the sole factor for trading.
• The risk-reward ratio is only usable when using the same language and capital for your other trades as well. It will become more comfortable for you to churn out a profit in the longer term.
• The risk-reward ratio must take into account the stop loss and target. It would be best if you did not place the target and the stop loss to satisfy a particular risk-reward ratio. It can prove detrimental in the longer run.
These precautions will help you use the risk-reward ratio to your advantage.
It is an important metric that you cannot ignore when trading in forex. It will help you avoid more significant losses. At the same point in time, you can bolster your strategy by using this metric while executing any trade. Forex trading need not be difficult as long as you use such technical parameters to your advantage.
All in all, whether you’re engaging in social trading (using our platform) or any other type of trading, this is a factor that you cannot ignore.